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Liquidity Pool Supply Sink Theory

February 28, 2022
Tyler Odenthal

We have had a lot of people ask why the BirdBot team is so interested in making LP Partnerships. This is because setting up more ASA / ASA pools allows for sharing of liquidity and more trades to happen. An increase in token velocity is not what a lot of creators are trying to increase, but my background in economics tells me that this is very critical to the long term success of a token.

"The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time." - St. Louis FED

"High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions." - Investopedia

Traditional Economics Applied to BirdBot LP Partnership + Staking Scenario

Supply Sink Theory via ASA Liquidity Partnerships

1 - The Main Pool

When you set up an ALGO / BIRDS pair that allows people to trade ALGO for BIRDS and vice versa.

When people create a trade using TinyMan that will create an imbalance in your ALGO / BIRDS pool.

This imbalance in the Liquidity Pool is how your token price is determined.

The more people that trade ALGO for BIRDS, the less BIRDS is in the pool, thus there is an arbitrage situation IF there are other trading pairs.

2 - Shared Liquidity Ecosystem

This is where the BIRDS / ASA pools comes into play.

Due to the liquidity imbalance in the ALGO / BIRDS pool, a trade can be made on the BIRDS / ASA pools in order to equalize the main pool slightly.

Based on the strength of "shared" liquidity through the LP partner ecosystem the movement will differ.

For example, BIRDS will take liquidity automatically from ASA partners in times of extreme downward sell pressure on BIRDS.

In times of extreme BIRDS buy pressure, the liquidity ecosystem will also share in gains by the creation of an arbitrage situation in the buy direction.

This liquidity sharing from buy pressure will be seen as a tiny chopping off on the tops of buy candles, which will be arbitrage liquidity going to your ecosystem partners.

3 - Supply Sink Through Arbitrage

These arbitrage situations mean that ALGO / BIRDS earns trading fees and the BIRDS / ASA pairs also earn trading fees.

Bots will leverage these arbitrage situations to make micro profit on a trading pair. There is no way to stop the bots, so we need to game the bots.

These fees are automatically accumulated by your TinyMan LP tokens, but you may notice that your LP tokens might be worth different ASA distributions.

It is often that when you withdraw from a liquidity pool, you will have a different ASA distribution than when you put in due to the nature of liquidity pools.

You can view the fees from liquidity pools as a supply sink or fee sink if you plan to never extract the fees from the pool.

4 - Supply Sink Effects on Token Price

Fee sinks, which are often a mechanic used in video games (WoW / Runescape) and traditional economics, can also be used in Tokenomics

These liquidity pool fees over the year can have a significant impact on token price by taking supply out of the market and "burning" it.

BirdBot - LP Partnerships Fee Calculator:

Fees generated through the 6 pools that TinyMan had fee data for.

Assuming we own 50% of these fees, that is a yearly BIRDS burn of around $9,769.69 USD.

Assuming that other ASA partners continue to hold their fees, yearly BIRDS burn is $18,324.18 USD.